Checking in on 2016 performance

We thought it was time to have a look at overall industry performance metrics over the past six months since our last article was published. You may recall, in early March there were signs of a price recovery for crude oil, and we speculated as to whether that recovery would be sustained. As it turned out, the February average monthly price for crude oil turned out to be the lowest of the year, so the recovery was reasonably robust. This is not to say that that the remainder of the year had stellar pricing realizations, but at least we didn’t linger in the doldrums of $30.00/bbl oil for long. The average price to date realized in 2016 is $42.00/bbl.

The recovery has been, as predicted, slow and painful. As we write this article, crude prices have again fallen off after touching on $50.00/bbl in October. In fact, October was the second time that we reached $50.00 and then fell back. This is suggestive of a limit to possible price recoveries while storage volumes remain at the current level. Even as overall US production volumes have fallen off over the year (550 Mbbl/d lower than 2015), storage has continued to build year on year, with the most recent US crude oil inventory at 483 MMbbl and US commercial inventory at 1.34 Bbbl compared to inventories of 449 MMbbl and 1.29 Bbbl at the end of 2015.

While these numbers are lower than the peak volumes earlier in the year, they are still indicative of a continuing oversupply in the market. The question remains as to whether this is still a hangover of the “fraclog” or if cost reductions in the industry have created economic opportunities that did not exist two years ago. It is Barchan’s view that both of these are factors in play.

It is of interest to note that while production peaked in the first half of 2015 in the Eagle Ford and Bakken plays, the Permian is different. Production continued to rise in the Permian, was largely flat through the second and third quarter of 2016, and in fact has now started to increase over the last month or so. This is strong evidence in our view that the cost of supply in the Permian basin is now less than $50.00, perhaps approaching $40.00. The recent Drilling Production report from the EIA (Nov. 12, 2016) shows over 5000 DUC (drilled but uncompleted) wells as of October 2016, and over half of these are in the Permian and Eagle Ford basins.

We turn now to the natural gas market. To date in 2016 (October), US natural gas production and imports has averaged 77.4 bcf/d and natural gas pricing for 2016 has averaged $2.42/mmbtu. On the production side, this represents a decline of about 1.3 bcf/d from 2015 levels, the first time the industry has seen a decline since 2005. This should be a good sign for future pricing. This positive sign however is tempered with other factors also coming to bear on the price of natural gas.

Rig counts are again increasing in the US, particularly in the Permian basin, but also in other areas. In the Permian, this has resulted in both liquid and associated gas production increases over the past two months. Another notable increase has been seen in the Marcellus basin which has also seen increased activity levels. As rig counts ramp up, can the other basins be far behind?

Since storage levels are already at historic highs, it is hard to view the increasing production as a positive. Secondly, we have experienced warmer than average fall temperatures so far (October HDD days were 38% lower than the 10 year average). Current predictions are for a colder than normal winter, but if that fails to show up, gas prices will stay in the depressed range of 2016. For the record, NOAA is currently predicting a colder than average winter on the eastern seaboard, whereas the Farmer’s Almanac is predicting a warmer than average winter.

As it is dangerous to consider things in a North American vacuum, a brief look at the global situation is also in order. Demand is strong for energy, with overall world consumption for petroleum and liquids continuing to grow. Consumption in 2016 is trending to 95.4 MMBbl/d, up close to 1.5MMBbl/d from 2015. Predictions for continued growth in demand are in the same order for 2017.

Paralleling this growth in consumption, overall global supply has also grown and exceeded the demand growth, aided by increases in production from Saudi Arabia, Iran, Russia and others. The resulting global oversupply is averaging around 650 MMbbl/d at the end of October. It remains to be seen whether OPEC will reach agreement in November to curtail production as reported this past September. We will be watching along with you to see what unfolds as it will surely have at least a short term impact.

So what to make of all of these ramblings? First, it has to be acknowledged that our industry has once again proven itself to be very resilient in the face of adverse conditions. Costs and technological improvements have resulted in increased activity in at least some of the tight oil plays even as pricing remains sub $50.00. Second, there is still a supply and demand imbalance, although hopeful signs are on the horizon that this will be remedied in the near future. And finally, we continue to believe that 2017 will be a year of challenging economic conditions for oil and gas producers in North America, and that the industry will see only a slow recovery in price for oil with the price of natural gas remaining more or less flat.